Opinion | The viability of income sharing in education finance

Loknath DasJanuary 23, 2019EducationComments Off on Opinion | The viability of income sharing in education finance

Avinash M Tripathi

Strap In an income-sharing model, students do not have to pay any upfront enrollment or tuition fee, but will share a certain percentage of their annual income for a specified period.

Increasing college tuition fee has pushed higher education out of reach, even for the middle class, not to speak of those at bottom of the income pyramid. Education loans can mitigate some of the problems, but only up to a point. One alternative educational financing model that has received attention in recent times is the income sharing agreement (ISA). Recently, Lambda School, an online coding school that pioneered this funding model, has received venture capital financing to the tune of $30 million.

In this model, students do not have to pay any upfront enrollment or tuition fee. Instead, they sign an agreement stipulating that they will share a certain percentage (around 17 percent) of their annual earning with the education provider for a fixed period. This income sharing clause gets triggered only if the student manages to start earning within a certain time period.

Will this model prove effective in handling bottlenecks in the education sector? This is not merely an academic question. Advanced economies like the US are dealing with a high level of income inequality which has distorted their political economy. It has been established conclusively by economists such as Raj Chetty and his co-authors that one important leveller is the access to higher education. With a large youth population and challenges in financing tertiary education, developing countries like India should explore this model.

One positive thing about ISA is the efficient risk sharing between the student and the education provider. If we think of education as an investment, then in the traditional model of educational finance, the entire risk is borne by a student.

This is somewhat counter-intuitive because compared to a formal institution, the student should be more risk-averse. Arguably, an optimal contract would entail a greater degree of risk-bearing by education providers. ISA is the perfect instrument to achieve this.

What it means in practice is that students who are competent, but are worried about debt repayment, can take advantage of this option. This will expand the pool of educated and skilled manpower, and will be a win-win for both the education providers and students—ultimately benefiting the economy.

Not everything will be hunky-dory, however. One can think of at least three main challenges this model can face, especially in a developing country like India.

The first challenge will be related to contract enforcement. Compared to a plain educational loan, ISA is a more complex contract. It requires greater effort in terms of monitoring future income and enforcing payments. Disputes are bound to emerge and a speedy resolution will be key to the success of this model. Unfortunately, according to the World Bank, India is one of the worst performers in terms of contract enforcement—a typical contract takes more than 1,445 days to get resolved. This will be a big hindrance to Lambda School type experiments in India, unless policy measures are undertaken to alleviate the problem.

Second, in traditional educational loans, the student is the sole residual claimant to future earnings. Consequently, she has strong incentives to find and retain a job. Income sharing agreements taking away a certain percentage of earnings attenuates the incentives to earn more at the margin.

If the part of the income being extracted by the education provider is too high, the student might decide to drop out from the labour market altogether. Even in the moderate rate case, there are a variety of strategies available to the student to slack off. One implication of this incentive problem is that these schools will need to screen, not merely the student’s aptitude, but also the level of motivation. Further, the income share claimed by the education provider cannot be too high.

Third, the success of this model will also raise concerns about what economists call ‘cream-skimming’. Typically, educational institutions cross-subsidize non-lucrative but vital disciplines like mathematics, basic sciences, humanities and social sciences by charging more from lucrative and marketable courses. As more standalone profit-oriented courses like Lambda School become popular, this model will face competition and difficulties, unless supported by public funds and private philanthropy. This is unlikely to be in public interest.

In conclusion, ISA is an important institutional innovation in an important sector. It can certainly expand the pool of skilled labour in an economy. However, it is unlikely to be a magic wand that can fix all the woes.

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